Which of the following statements best describes the significance of competition in relation to consumer surplus and willingness to pay?

• A. Competition increases consumer surplus by driving prices closer to consumers' willingness to pay.
• B. Competition decreases consumer surplus by allowing firms to charge higher prices.
• C. Competition has no effect on consumer surplus or willingness to pay.
• D. Competition reduces consumers' willingness to pay for goods and services.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of consumer surplus. Consumer surplus is the difference between what consumers are willing to pay for a good or service and what they actually pay. It measures the benefit consumers receive from purchasing at a lower price than their maximum willingness to pay.
2. Step 2: Recognize the role of competition in markets. Competition among firms tends to drive prices down because firms compete to attract consumers by offering better prices or value.
3. Step 3: Analyze how competition affects prices relative to willingness to pay. When competition increases, prices tend to move closer to the marginal cost of production, which is often lower than consumers' maximum willingness to pay.
4. Step 4: Connect the effect of competition on consumer surplus. Since prices decrease and approach consumers' willingness to pay, the gap between willingness to pay and actual price widens, increasing consumer surplus.
5. Step 5: Conclude that competition benefits consumers by increasing consumer surplus through lower prices, rather than decreasing consumer surplus or having no effect.